Deflation Fears Turn Into Reality
Consumers Delay Buying, Forcing More Production Cut
By Kim Tae-gyu
Staff Reporter
Fears of deflation at home and abroad are looming larger as prices of commodities including oil and metals have begun to plummet amid the ongoing financial crisis, following those of shares and real estate.
The opposite of inflation, deflation refers to a decline in general price levels, which creates expectations that they will drop further, choking consumption.
Thus far, asset deflation including shares and houses has mainly plagued policymakers both locally and globally, but now they have to worry about it becoming full-fledged.
Crude oil prices have experienced a free fall from a peak of above $145 per barrel in July to about $55 in four months, which threatens the break-even point for oil producers.
According to Roubini Global Economics (RGE), the U.S.-based financial analysis firm, miners of nickel and zinc have already cut production, as prices are 50 percent below historical averages.
Steel prices have also dipped from above $1,200 per ton earlier in June to below $300 because of weak demand.
``Commodity indices have lost 50 percent of their value since their July peak. With the Group of 10 in recession and many emerging economies slowing sharply, further demand decrease is likely,'' RGE said in a document posted on its Web site.
``Once the price adjustment filters through to producers, they may account for another source of slower aggregate output,'' said RGE, headed by Nouriel Roubini, an economics professor at New York University who has recently gained prominence for predicting the global financial storm a couple of years ago.
On a more negative note, commodities prices are expected to dive further, as they overshot during the boom period of the early 2000s.
``Despite the steep price declines so far, commodities have only fallen halfway to their 2001-2002 trough, meaning they may have farther to fall,'' RGE said.
``In fact, some investors are pricing in a temporary drop in the price of oil to below $30 per barrel, far below marginal production costs,'' it said.
No Quick Fix
Things are similar in Korea, where asset deflation is already underway, as share prices have halved over the past year and values of homes also decreased substantially.
Should falling prices of commodities cause general deflation, it will create a vicious circle and dent the economy ― people's reluctance to spend forces firms to slash production. This will lead to massive layoffs and further reduction in consumption, which causes more production cuts.
The real downside of the possible deflation is that there is no quick fix to address it because the world is not likely to return to an era when companies financed their growth via huge debts.
``Long-run fundamentals of supply and demand suggest a resumption of the up-trend in commodity prices in a few years, but a global recession, a strong dollar and forced fund liquidations in the medium-term will keep prices under pressure until late 2009,'' RGE said.
``The anticipated price recovery will be gradual if the current financial crisis permanently restricts the ability to leverage, which was key to the world's high growth rates posted in the past few years,'' it said.